Employees of nonpublic companies not eligible for SOX protection

In Lawson v. Fidelity Management & Research, LLC, the 1st Circuit ruled on Feb. 3 that the whistleblower protection provision of section 806 of the Sarbanes- Oxley Act of 2002 (SOX) does not apply to employees of nonpublic companies, even those who work for private contractors or subcontractors to public companies.

The plaintiffs, Jackie Lawson and Jonathan Zang, filed two separate but similar suits, each alleging retaliation by their employers—private, contracted advisers to the Fidelity mutual funds—for raising concerns over potential securities fraud and cost inaccuracies, which resulted in the loss of their jobs.

The district court, addressing both cases, ruled that the whistleblower provision covered contractors and subcontractors of public employees. But the private companies disagreed, arguing that Lawson and Zang were not covered and had not engaged in protected activity. The defendants moved for interlocutory appeal.

The district court granted the motion and sent the case to the 1st Circuit to determine if the whistleblower provision applied to employees of contractors or subcontractors of public companies.

The 1st Circuit ruled that it did not, relying heavily on the language of the statute to reach its 2-1 majority decision.

Scrutinizing Statutes

The title of section 806 is “Protection for Employees of Publicly Traded Companies Who Provide Evidence of Fraud.” Subsection (a) forbids companies with securities registered under section 12 of the Securities Exchange Act of 1934 or “any officer, employee, contractor, subcontractor, or agent of such company” from discriminating against employees who report securities violations.

The plaintiffs interpreted this phrase to mean that contractors and subcontractors were included in the term “employee,” and thus protected. The defendants read the phrase as the list of who is forbidden from retaliating against protected employees. The 1st Circuit extracted the phrase “publicly traded companies,” included both in the title and body of the statute, as “statements of congressional intent which go against plaintiffs’ interpretation,” and agreed with the defendants.

Elsewhere in SOX, when Congress intended to give broader protection, it did so explicitly, the 1st Circuit wrote. One such example the court cites is in section 1107 of SOX, where Congress writes, “Whoever knowingly, with the intent to retaliate, takes any action harmful to any person …” The phrases “whoever” and “any person” in this case suggest wider protection than that provided in section 806.

The dissent, however, felt that the majority opinion imposed “an unwarranted restriction on the intentionally broad language of SOX,” and said that because the statute did not explicitly deny protection to contractors and subcontractors, they are protected. It goes on to quote the majority opinion as saying that “different readings may be given” to the statute, and therefore it is not “clear” as the majority later claims it to be.

In the end, though, the majority wrote that the court is “bound by what Congress has written.” If Congress “intended SOX protections to apply more broadly to employees of contractors, then it’s going to have to legislate,” says Rebecca Katz, a partner in the whistleblower practice at Bernstein Liebhard.

Private Alternative

Lawson takes protection away from an entire class of workers. Many public mutual funds such as Fidelity, the defendants in this case, do not have employees other than contractors, rendering this statute inapplicable to them.

“It’s really hard to be a whistleblower to begin with,” says Tammy Marzigliano, a partner at Outten & Golden. “Decisions like this make it even harder for these people to come forward.”

However, the Dodd-Frank Act of 2010 “captures, potentially, some of those people that would otherwise, by this decision, not have any legal recourse,” Marzigliano says.

Dodd-Frank covers all employees, even those at private companies, who blow the whistle on securities fraud, but they have to report to the Securities and Exchange Commission (SEC). However, a recent case may have created wiggle room for internal reporters looking to be covered under Dodd-Frank (see “Egan Exception”).

What this means is that employees who work for private contractors are likely not going to report internally and instead head straight for the SEC to ensure Dodd-Frank protections.

To prevent this, in-house counsel should institute policies that reward employees for reporting internally, and have strict prohibitions against retaliation, Katz says.

The Equal Employment Opportunity Commission reported that in 2011, for the first time, retaliation surpassed race as the most charged form of discrimination.

Although Lawson says SOX protection doesn’t apply to contractors of public companies, the language is ambiguous enough that another court may not agree. Meanwhile, experts emphasize that even if nonpublic employees don’t head straight to the SEC to blow the whistle, retaliation claims are on the rise. All of which are good reasons for companies to put a strong anti-retaliation policy in place.